November 11, 2022

Douglas Porter

The surprising low-side October CPI was the week’s big economic event, readily overshadowing the mixed midterm results. Markets rallied furiously in the wake of the lowest core CPI reading in over a year, lifting stocks to their biggest daily gain in two years while submarining bond yields and the U.S. dollar. Aside: the +0.27% core result would have vied for the highest of the 2010s—there was no increase above 0.30% in that decade—yet is now seen as blissfully mild. In fairness, this was truly the first heavy inflation undershoot in nearly two years, and it does give some tantalizing signs that the worm has turned, especially for goods prices. This week’s Focus Feature digs into much greater detail on this topic, but the main message is that while inflation does seem headed lower, we remain quite concerned that it won’t go quietly into the night.

Another key takeaway from the surprising CPI result is to pound home the point, yet again, that no one knows for sure where inflation is headed, other than it will prove to be volatile. Note that the moderate October result followed hard on the heels of back-to-back 0.6% core increases, both of which were handily above consensus, and the three-month trend is still a meaty 5.8% (a.r.). So, while inflation hawks were eating crow Thursday, this followed a long spell where Team Transitory had its hat handed to it, and inflation-deniers had been humiliated.

The reason for the pervasive uncertainty is that almost no one currently working in finance, economics, markets, or policymaking circles has any real-world experience dealing with real inflation. For example, the last time the U.S. economy saw double-digit CPI readings was in November 1981, at the tail end of roughly an eight-year episode of high and volatile inflation. For Canada, the last double-digit reading was in September 1982. For France and Australia, it was in 1983, while Japan last saw such high inflation in 1976 and for Germany it was way back in 1951! Combining the G7, October 1981 marked the last double-digit inflation result. So, for most, it’s been more than forty years since inflation was close to current levels.

Now, let’s look at where 10 policymakers or key thought leaders were in the early 1980s. (Profound thanks to that font of infinite wisdom, Wikipedia, for these tidbits.)

• Jerome Powell: After clerking for a judge in NYC, he was a lawyer at Davis, Polk and Wardwell from 1981-83.
• Christine Lagarde: In 1981, she joined the law firm of Baker & McKenzie, working on antitrust cases.
• Andrew Bailey: Working on his PhD in history at Cambridge (his thesis was on the impact of the Napoleonic wars on the cotton industry).
• Tiff Macklem: An undergraduate student at Queen’s University until 1983.
• Mark Carney: Attended high school in Edmonton.
• Chrystia Freeland: Also attended high school in Edmonton (Old Scona).
• Justin Trudeau: Attended public elementary school in Ottawa (Rockliffe Park).
• Joe Biden: U.S. Senator, and was on the Senate Judiciary Committee.
• Janet Yellen: Was a staff economist at the Fed in the 1970s, and began teaching macroeconomics at Berkeley’s business school in 1980.
• John Williams: The NY Fed President studied at Berkeley in the early 1980s.

So, among these 10 key decision-makers and influencers, only Janet Yellen was working in finance and economics during the Great Inflation of the 1970s and early 1980s, although Joe Biden no doubt would have been dealing with it heavily in his work in the Senate. However, those two were arguably the leaders of Team Transitory, and simply did not see the burst in inflation coming.

Again, the main goal of this exercise is to drive home the fact that almost no one now making the decisions and/or actively driving the markets has any hands-on experience with true inflation. Thus, almost by definition, mistakes will be made. And, thus, every commentator, analyst, and pundit should be somewhat humble about their ability to predict what is going to unfold in the year ahead for inflation, rates, broader financial markets and thus the economy.

Alas, humility remains in amazingly short supply among the punditry. Those of the bullish persuasion—for either stocks or bonds—seized on the CPI result as proof positive that the peak is in, and it’s all downhill for price pressures from here. For their part, inflation hawks were quick to point to still-rising service prices, while noting the still-present risks from both food and energy costs. We clearly lean to the latter camp (if not the standard-bearers of it).

The latest Blue Chip consensus survey can help frame the debate: Taken just before the latest CPI release, it finds that the average forecast for 2023 CPI inflation is 4.2% (versus 8.1% this year, and October’s actual 7.7%). The range among those surveyed ran all the way from a low of 1.0% to a high of 5.8% (we’re now at 5.0%, which puts us well into the highest quintile).

We’ll conclude by noting that at the start of 2021, when Joe Biden was preparing to unleash a massive stimulus package, the Blue Chip consensus for CPI inflation for 2022 was 2.1%, or roughly 6 full percentage points south of reality. Again, we really should all be humble in our collective ability to judge where things are headed next, and thus prepare for a range of possibilities in this complex economic backdrop.

In the immediate aftermath of the U.S. CPI, the natural question was how the mild reading would map into the Canadian result this coming Wednesday. The short answer is: Not very well. Medical care services had one of the largest declines ever (-0.6%), alone shaving core by at least a tenth. That won’t even register in Canada. Used car prices plunged 2.4%, natgas prices were off 4.6%, and owners’ equivalent rent eased a bit. These factors either aren’t in the Canadian CPI, or will look quite different here. Meantime, while food inflation backed off slightly in the U.S. figures, Canadian costs may have been pressured by a weaker loonie. Finally, pump prices look to have jumped roughly 8% in October versus the moderate 4% rise seen stateside.

So, we are bracing for a hefty 1% jump in Canadian prices, which will boost the annual rate back up above 7%, narrowing the gap with U.S. inflation to just half a point. That’s the narrowest spread since early 2021, and follows last week’s crossover in average hourly wages, which saw Canada’s perk up to 5.6% y/y versus the U.S. deceleration to 4.7%. While we continue to see a lower terminal rate for the Bank of Canada at 4.5% against 4.75%-to-5.00% for the Fed, the case for such is becoming a bit less air-tight.

Douglas Porter is chief economist and managing director, BMO Financial Group. His weekly Talking Points memo is published by Policy Online with permission from BMO.